Sunday, November 11, 2012

A Simple Reason Not to Buy Eastman Kodak

Eastman Kodak (EK) may be one of the world's most recognizable brands over the last several decades, but stock investors should stay away because time is not on their side.

The iconic company's stock price decline has not been a recent development. But EK was once again in the news for the wrong reasons after they drew down on $160 million from their revolving bank line for "general corporate purposes." The stock now trades close to its 52-week low and well off the 52-week high of nearly $6 per share.

To be clear, we are not advising individuals to short the stock. We just think shareholders would be best served by avoiding this stock. Sure, there is upside potential if they sell their phone patent portfolio for premium levels, but this depends on exogenous parties and factors that do not necessarily operate with the same sense of urgency as Eastman Kodak management and shareholders. In addition, potential investors should remember that the valuation on patents is somewhat inflated by a handful of recent acquisitions by behemoths like Google (GOOG). Without these companies bidding, it is hard to judge what the next highest bids would be. The valuations on patents is not well defined nor is it linear. Remember that the $4.5 billion winning bid for Nortel's patent portfolio was around five times larger than the next highest bid from Google for the same patents.

Investors may be drawn to the stock because of the lottery ticket take payoff potential. With a price/sales of 0.07, it clearly wouldn't take a big change in the margins or business fundamentals to drive a higher stock price. But the business trends are not promising, especially as we head into a period of slowing domestic growth. In 2009 and 2010, EK reported $8.10 billion and $8.09 billion of revenues. During the trailing twelve month period, revenues were around $6.5 billion.

Readers may wonder why we highlighted Eastman Kodak without including other distressed technology companies like Nokia (NOK) and Research in Motion (RIMM). True, investors for these three companies are staking large parts of their bullish theses on potential buyouts by larger companies. Investors most likely want Eastman Kodak acquired for its patent portfolio and Nokia acquired by Microsoft (MSFT) for its manufacturing and design expertise. The potential acquirers of RIMM are a bit more diverse, but investors are also generally pushing for a major overhaul that ultimately leads to a buyout by Microsoft or another major industry participant.

But there is a difference between Kodak and the other companies. Unlike Kodak, Nokia and Research in Motion still have upside even without a buyout. While they have struggled so far, it is not out of the question for Nokia to succeed in their recent venture with Microsoft and it is hard to ignore that despite their numerous failures, RIMM still has a stubbornly loyal enterprise customer base. And because the enterprise customers are drawn by security rather than style, this loyalty could persist in the near term.

In the best-case scenario, Kodak has upside. But why buy a company's stock when the bad case scenario is a permanent capital loss and the best case scenario is dependent on the kindness of strangers? Sirius XM Radio (SIRI) may be viewed by some as a major distressed stock success story. True, it has rebounded strongly from its financial crisis lows, but it has been a rocky road littered with investors that may never regain their full capital investments. Also, the stock had a growing underlying operation, and the corporation was just hampered by a burdensome capital structure. So in this case, SIRI was also different from Eastman Kodak.

Disclosure: I am long AAPL. I may initiate a long short position in MSFT, SIRI, GOOG, RIMM over the next 72 hours. I receive no compensation to write about any specific stock, sector or theme.